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What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. That's why when we briefly looked at Shoe Zone's (LON:SHOE) ROCE trend, we were very happy with what we saw.
Understanding Return On Capital Employed (ROCE)
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Shoe Zone is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.25 = UK£15m ÷ (UK£102m - UK£41m) (Based on the trailing twelve months to October 2022).
Therefore, Shoe Zone has an ROCE of 25%. In absolute terms that's a great return and it's even better than the Specialty Retail industry average of 13%.
See our latest analysis for Shoe Zone
Above you can see how the current ROCE for Shoe Zone compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What The Trend Of ROCE Can Tell Us
In terms of Shoe Zone's history of ROCE, it's quite impressive. Over the past five years, ROCE has remained relatively flat at around 25% and the business has deployed 52% more capital into its operations. With returns that high, it's great that the business can continually reinvest its money at such appealing rates of return. You'll see this when looking at well operated businesses or favorable business models.
Another thing to note, Shoe Zone has a high ratio of current liabilities to total assets of 40%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
The Bottom Line On Shoe Zone's ROCE
In short, we'd argue Shoe Zone has the makings of a multi-bagger since its been able to compound its capital at very profitable rates of return. And since the stock has risen strongly over the last five years, it appears the market might expect this trend to continue. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.